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On Jun 12, the National Federation of Independent Business (NFIB) released data for its small-cap business optimism index, which rose to its highest level in May since 1983. The key metric also touched its second-best settlement since its inception 45 years ago. Strong domestic economy and Trump government’s tax codes supported these gains.

Small-cap stocks are believed to have a higher level of volatility compared with their large and mid-cap counterparts but provide comparatively better returns. Small-cap stocks have better growth prospects following strengthening business optimism and a low tax environment. Moreover, tariff-related uncertainty makes these mostly domestic-focused stocks wise investment choices.

Small Business Sentiment Index Near Record High

The NFIB small-business optimism index increased 3 points to 107.8 in May. Out of the 10 major components in the index, eight registered an increase, while one was unchanged.

Three key components of the index, which are higher sales prospects, a better economy and strong expansion plans rose 10%, 7% and 7%, respectively. Positive sales trends reached its best level since 1995, while expansion plans settled a 45-year high.

Moreover, employee compensation touched its highest settlement in 45 years, which in turn is projected to boost labor participation rate in small-cap businesses. Additionally, encouraging earnings trends also rose 3%, touching its best levels since 1973.

Trump’s Tariffs and Tax Cuts Help Small Caps

NFIB President Juanita Duggan said “main Street optimism is on a stratospheric trajectory” following recent regulatory changes and tax cuts. He added that easing regulations and lower taxes, along with a surge in “earnings and employee compensation,” will act as the key drivers to boost small businesses.

On May 31, President Trump slapped tariffs of 25% on steel imports and 10% on aluminum imports from allies Canada and Mexico as well as from the member countries of the European Union. It came into effect on Jun 1. This could create turbulence for large companies with multinational operations.

Moreover, Trump’s Tax Cuts and Jobs Act of 2017, permanently slashed corporate tax rates from 35% to 21%, which is a tailwind for small caps. Before the tax cut, the small-cap companies on the Russell 2000 index had to pay a median effective tax rate of 31.9%, which is around 4% higher than the same paid by S&P 500 components, according to Thomson Reuters.

Our Choices

Strong business sentiment, stronger domestic economy, upbeat jobs report and a low tax scenario bode well for small-cap stocks. Moreover, President Trump-induced tariff-related concerns are also good news for small-cap stocks.

Given this backdrop, it makes sense to bet on small-cap stocks, which are included on the Russell 2000 index. Notably, this prominent small-cap index has jumped 9.6% so far this year, which is considerably higher than the Dow’s increase of 2.4% and the S&P 500’s rise of 4.2% during the same period.

These five stocks flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy). However, picking winning stocks may be difficult. This is where our VGM Score comes in. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM Score.

We have narrowed down our search to the following stocks based on a good Zacks Rank and VGM Score.

Covenant Transportation Group, Inc. is a provider of truckload transportation and brokerage services primarily in the continental United States.

Covenant Transportation Group has a VGM Score of A. The expected earnings growth of the company for the current year is more than 100%. The Zacks Consensus Estimate for the current year has improved 6.7% over the last 30 days. Covenant Transportation Group has gained 24.5% in the past three months. The stock sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Shoe Carnival, Inc. is a major family footwear retailer in the United States.

Shoe Carnival has a Zacks Rank #1 and VGM Score of B. The company has expected earnings growth of 35.9% for the current year. The Zacks Consensus Estimate for the current year has improved 5.2% over the last 30 days. Shoe Carnival has gained 44.5% in the past three months.

RCI Hospitality Holdings, Inc. is involved in the hospitality and related businesses in the United States.

RCI Hospitality Holdings has a Zacks Rank #2 and VGM Score of A. The company has expected earnings growth of 52.1% for the current year. The Zacks Consensus Estimate for the current year has improved 4.8% over the last 30 days. RCI Hospitality Holdings has gained 8.7% in the past three months.

Comtech Telecommunications Corp. is a developer of products, systems, and services for communications solutions.

Comtech Telecommunications has a Zacks Rank #1 and VGM Score of B. The company has expected earnings growth of more than 100% for the current year. The Zacks Consensus Estimate for the current year has improved 2.7% over the last 30 days. Comtech Telecommunications has gained 4.4% in the past three months.

Xcerra Corp. is a provider of test and handling capital equipment, interface products, and test fixtures to the semiconductor and related industries.

Xcerra has a Zacks Rank #2 and VGM Score of A. The company has expected earnings growth of more than 100% for the current year. The Zacks Consensus Estimate for the current year has improved 4% over the last 30 days. Xcerra has gained 26.9% in the past three months.

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Last year, it generated $8 billion in global revenues. By 2020, it's predicted to blast through the roof to $47 billion. Famed investor Mark Cuban says it will produce "the world's first trillionaires," but that should still leave plenty of money for regular investors who make the right trades early.

Zacks Equity Research provides the best of quantitative and qualitative analysis to help investors know what stocks to buy and which to sell for the long-term.

Continuous coverage is provided for a universe of 1,150 publicly traded stocks. Our analysts are organized by industry which gives them keen insights to developments that affect company profits and stock performance. Recommendations and target prices are six-month time horizons.

Strong Stocks that Should Be in the News

Many are little publicized and fly under the Wall Street radar. They're virtually unknown to the general public. Yet today's 220 Zacks Rank #1 "Strong Buys" were generated by the stock-picking system that has nearly tripled the market from 1988 through 2015. Its average gain has been a stellar +26% per year. See these high-potential stocks free >>.

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Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Zacks Investment Research does not engage in investment banking, market making or asset management activities of any securities. These returns are from hypothetical portfolios consisting of stocks with Zacks Rank = 1 that were rebalanced monthly with zero transaction costs. These are not the returns of actual portfolios of stocks. The S&P 500 is an unmanaged index. Visit https://www.zacks.com/performance for information about the performance numbers displayed in this press release.

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At the center of everything we do is a strong commitment to independent research and sharing its profitable discoveries with investors. This dedication to giving investors a trading advantage led to the creation of our proven Zacks Rank stock-rating system. Since 1988 it has more than doubled the S&P 500 with an average gain of +25% per year. These returns cover a period from 1988-2017. Zacks Rank stock-rating system returns are computed monthly based on the beginning of the month and end of the month Zacks Rank stock prices plus any dividends received during that particular month. A simple, equally-weighted average return of all Zacks Rank stocks is calculated to determine the monthly return. The monthly returns are then compounded to arrive at the annual return. Only Zacks Rank stocks included in Zacks hypothetical portfolios at the beginning of each month are included in the return calculations. Zacks Ranks stocks can, and often do, change throughout the month. Certain Zacks Rank stocks for which no month-end price was available, pricing information was not collected, or for certain other reasons have been excluded from these return calculations.

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